Defensive Stocks Decline; Small Caps Underperform

By the Curmudgeon with Victor Sperandeo


Despite wobbling for the past three months, 2023 has been a stellar year for most U.S. stock indexes and sectors.  The S&P 500 total return is + 14.2% YTD, the NASDAQ Composite is +26.9%, and the NASDAQ 100 is +30%.  But not all stock sectors have done nearly that well.

Selling pressure in some defensive stocks has been incredibly strong.  Recession resistant defensive sectors like Utilities, Health Care, and Consumer Staples have been hit hard in 2023.

Utilities are usually considered among the safest bets in the stock market, suitable for “widows and orphans,” and offer some of the highest dividends. Nonetheless, they have declined ~ -15% this year, the worst-performing sector in the S&P 500 index. 

Separately, small cap stocks have continued to underperform large caps and that trend is likely to continue.

Victor concludes with a review of asset class performance from the end of 2021 to date.  The results will be a surprise to most Curmudgeon readers.  It was a surprise to me!

Defensive Stocks Unexpectedly Decline in 2023:

Utilities (electric, energy, water) have been the weakest stock sector this year. After hitting a 52-week low of $54.93 on October 3rd, the XLU Utilities Select Sector SPDR ETF [1.] closed Friday at $59.30 +1.13% for the day, but its YTD total return is -13.9%. 

Note 1. The XLU tracks a market-cap-weighted index of U.S. utilities stocks drawn exclusively from the S&P 500.  This ETF dominates the utility sector, with huge assets and volume.

The Dow Jones Utility Average (DJU), with only 15 companies included, has also bounced off its October 2nd low, but has lost -14.77% YTD in 2023.

Telecom stocks (not included in the XLU or DJU) have had a horrible year - even worse than utilities.

l  The Dow Jones U.S. Telecommunications Index is -17.34% YTD. 

l  Despite an 8.67% dividend, Verizon (VZ) stock is -16.39% YTD.

l  AT&T (T) stock has performed slightly worse with a -16.74% YTD total return.

Sentimentrader averaged the McClellan Summation Indexes for the three defensive sectors. As per the chart below, we see that it has declined to one of the lowest levels in 70 years. It's now in the bottom 3% of all days since 1952!

A graph showing the average damage for defensive sectors

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 The McClellan Summation Index for Consumer Staples neared -1700 for one of the few times in 25 years.

The only two distinct occurrences were during the last two significant bear markets.

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The following chart shows that a reading below -1500 ranks in the bottom 1.5% of all days in the past 70 years.

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The difference in data sets is primarily due to a slight difference in the number of stocks in the sector that advanced or declined daily. Minor differences in daily figures can have an outsized impact on longer-term cumulative indicators like the Summation Index.

Even lesser extremes than we see now have preceded some further short-term weakness but medium- to long-term strength in the sector.


Small Stocks Continue to Lag:

This is one of the worst years in nearly a hundred for Small Cap stocks relative to Large Caps, based on their total returns through Friday. With Small Caps underperforming by more than -13%, the spread is the 8th-worst out of the last 95 years.

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The relative ratio between the two shows that smaller stocks had a strong tendency to continue to underperform. Even up to a year later, small stocks outperformed only 23% of the time, though once again the worst signals were concentrated in earlier decades.

Investors are fleeing small caps despite their low historical valuation. The forward P/E of the S&P 600 U.S. Small Cap Index is well below its historical average as shown in this chart:

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Small-Cap Index (Current P/E)

According to Yardeni Research, as of October 13th that index’s P/E is only 11.9 (vs. 18.0 for the S&P 500 Large Cap Index).

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Source: S&P Global


Victor’s Comments:

The U.S. stock market is focused on whether or not the Fed is done raising rates.  Will there be one more at the November 1st or December 14th FOMC meeting?

Most advisors and analysts are looking for the Fed to pivot in 2024 to lower rates as a recession hits “sometime soon.”  I have a different take on this as I’ve previously stated in this post: 

To recap, a recession will be avoided “at all costs” in 2024 because it’s a Presidential election year. As a result, there will be no cuts in U.S. government spending and inflation will continue unabated.  I believe the Fed and U.S. government secretly want higher inflation so that the national debt is repaid in “cheaper” U.S. dollars.

For now, there is some confusion on what various assets have done. All returns are relative to the environment you’re in.

Let’s review the performance of various asset classes from the end of 2021 (12/31/21- 10/13/23).  I use ETFs where possible, as they are the preferred investment vehicle of investors:

l  Small Caps (Russell 2000) using IWM -23.2%

l  Dow Jones Industrials (DJI) -7.4%

l  S&P 500 using SPY -9.2%

l  NASDAQ 100 using QQQ -12.57%

l  GOLD using GLD +4.6%

l  SILVER using SLV +.01%

l  Dollar Index using UUP +16.78% (DXY Index is +10.61%).

l  Intermediate U.S. Government Notes using IEI -12.2%

l  20+ Year U.S. Bonds using TLT -40.99%

l  Treasury Inflation Protection Securities using TIP -19.8%


l  CRUDE OIL using XLE +59.6%

l  BITCOIN ”PRICE” -41.9%

Clearly, Oil, Commodities, Gold, and the U.S. Dollar were in the green while Debt was far in the red. The CRB is heavily weighted to the positive energy complex returns. Despite double digit gains in 2023, U.S. stock indexes are still down by various amounts. 

Next year if the Dollar declines, Gold, and Silver should be up substantially. Oil should also do well if a recession is avoided. 

-->I will provide my 2024 forecast after the Fed’s November FOMC meeting.

End Quote:

”Inflation is legal counterfeiting; Counterfeiting is criminal inflation.”  Tweet by Robert Breedlove (a Bitcoin-focused entrepreneur, writer, and philosopher)

Be well, success, good luck and till next time………………

The Curmudgeon

Follow the Curmudgeon on Twitter @ajwdct247

Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies, and government policies.  Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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